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INTERVIEW
Editor’s Note: This is an abbreviated version of RF’s conversation with Michael Bordo.
For the full interview, go to our website: www.richmondfed.org/publications
Many observers have compared the financial crisis of
2007-2008 and the Great Recession to the Great
Depression. While one shouldn’t downplay the hardships that many Americans have suffered in the last four
plus years, a quick comparison of the raw data from
those two episodes demonstrates how much more mild
the Great Recession was, says monetary historian
Michael Bordo of Rutgers University. Roughly onequarter of Americans were out of work during the worst
period of the Great Depression compared to roughly
one-tenth during the Great Recession. Also, real GDP
dropped at a staggering pace in the early 1930s, about
25 percent, compared to a 5 percent drop during the
Great Recession.
In addition, the initial crises largely had different
causes, Bordo argues, and the sluggish economic recoveries following those crises can generally be attributed
to different factors. But in both cases, policy mistakes
by the Federal Reserve contributed to the economy not
rebounding more quickly. The Fed learned from the
Great Depression by providing much-needed liquidity
to the financial system after the crisis, but it engaged in
a “too big to fail” policy that made things worse and that
set a bad precedent for future actions. Moreover, the
Fed’s close collaboration with the Treasury Department
and other measures it took have greatly compromised
its independence. In Bordo’s view, the Fed should limit
the scope of its activities, focusing on price stability, and
should enact a transparent set of monetary policy rules in
lieu of a more discretionary approach to policymaking.
Internationally, Bordo’s historical work suggests that
monetary unions comprised of multiple nation-states
with separate fiscal agents tend to be relatively
fragile, a point that he argues is consistent with
recent developments in the eurozone. Ultimately, he
believes that eurozone policies will require significant
revision, though a single currency may be preserved in
a modified form.
Prior to joining the Rutgers faculty, Bordo taught at
the University of South Carolina and Carleton University
in his home country of Canada. In addition, he has held
visiting positions at numerous universities in the United
States and abroad, in addition to several central banks.
He was a visiting scholar at the Federal Reserve Bank of
Richmond in 1988. Aaron Steelman interviewed Bordo
by telephone from the Hoover Institution at Stanford
University, where Bordo is visiting during the 2011-2012
academic year.
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Region Focus | Fourth Quarter | 2011
RF: I would like to start off with an admittedly very
large question: What do you think were the proximate
causes of the financial crisis of 2007-2008?
Bordo: I think that the deepest problem, and it goes back to
the 1930s, is U.S. housing policy. The policy is generally to
encourage people to own homes, and it has been supported
by both political parties since the New Deal. I think it’s hard
to pin the blame on any one organization such as Fannie Mae
or Freddie Mac or the Federal Housing Authority, but rather
we should focus on the bundle of measures that have been
adopted over the last 75 years. So that sets up the background in that you have an official policy to encourage
people to own homes and thus to make mortgage finance as
easy as possible.
There were other factors as well. Diffuse financial regulation resulted in different agencies handling different parts of
the financial system with inadequate coordination to collectively understand the building up of leverage and the
growing exposure of the shadow banking system. We also
saw problems with corporate governance in that once the
incentives were there to expand cheap mortgages, the private sector came up with ideas leading to financial
innovation that produced some abuses. But in terms of
ordering, I don’t see corporate greed as causing the trouble.
I think it goes all the way back to housing policy and govern-
PHOTOGRAPHY: VISUAL ARTS SERVICES/STANFORD UNIVERSITY
Michael Bordo
I think that some people
all the numbers, every single one will
ment regulators being captured or
yield roughly the same relative difnot being on the ball.
mistakenly believe that
ference. The people who were
What I think fueled the credit
policy discretion helps to
talking about the Great Recession
boom that burst was expansionary
being comparable to the Great
monetary policy between about
sustain the independence of Depression were way off base.
2002 and 2005 on the mistaken
Still, there is the question of the
view, in my opinion, that we faced a
the Fed, when it actually
counterfactual: Had the Fed and
great risk of deflation. So the Fed
weakens it.
other central banks not implekept interest rates very low. That, I
mented a liquidity policy, would the
think, provided the fuel for the fire.
Great Recession have been as bad? My answer is that it
I don’t think monetary policy caused the crisis, but I think it
would have been worse than it was, but it would not have
played a very important ancillary role. And I think that Fed
been as bad as the Great Depression. We learned a lot of lespolicy has largely been misguided since the crisis hit. The
sons from the Great Depression. We have these automatic
Fed did the right thing in 2007 by viewing the situation as a
stabilizers in place, we have many more fail-safes, and the
liquidity crunch and being very expansionary. But then the
economy is different. It is now much less industrialized and
Fed sat on its hands in 2008 because it was worried about
much more service oriented.
commodity price inflation, and that got the recession going.
During the Great Recession the real problem was insolThen, of course, the Fed made huge mistakes by being
vency and the fear of counterparty insolvency. That really
inconsistent in the way it treated Bear Stearns and Lehman
wasn’t picked up by the Fed and other central banks until
Brothers. I think the Fed should have let Bear Stearns go.
quite late. They didn’t understand that in 2007 or even in
There would have been a lot of fallout from that but not as
early 2008. They thought it was fully a liquidity problem.
much as was caused by bailing them out and then letting
And when it became clear it was an insolvency problem, they
Lehman Brothers go. And then, of course, the Fed bailed out
shifted gears and got into bailout mode. That produced
AIG and the Treasury put Fannie Mae and Freddie Mac into
another series of mistakes because the “too big to fail” docconservatorship. There was a lot of inconsistency and that
trine was invoked, but it wasn’t just invoked for banks, it was
made things much worse.
invoked for both financial and nonfinancial firms. This is a
An issue that I don’t think was a big problem, but that
very key difference between the 1930s and now. In the 1930s,
many others do, was the global savings glut. I just don’t see
the United States did not follow too big to fail. But we also
these global imbalances as causing the subprime crisis.
didn’t follow Bagehot’s rule either. Instead, we allowed
I think it was much more of a homegrown, U.S.-created
everyone to go.
crisis that spread to the rest of the world. I am aware that
Regarding long-term economic consequences, the bankthere were housing busts in parts of Europe, such as Spain,
ing and financial systems were blamed for the Great
Ireland, and the United Kingdom. But I think that the U.S.
Depression. So we got New Deal financial regulation, which
story with subprime and the extent of the kinds of practices
greatly suppressed financial innovation and it greatly
that took place were unique. Europe has had many housing
reduced risk-taking in the financial sector. The governance
booms and busts, and I think that the U.S. event was caused
of the Federal Reserve also changed substantially. From 1935
mostly but not entirely by U.S. forces.
to 1951, it lost its independence and became subservient to
the Treasury. Further down the road, all the financial supRF: What commonalities and what differences do you
pression that was instituted led to evasion and financial
see between the policy responses and the longer-term
innovation and that led to new sources of systemic risk. So,
economic consequences stemming from the Great
in a sense, the consequences of the New Deal regulations
Depression and the Great Recession?
took many decades to get worked out but they were entirely
unintended.
Bordo: There are some big differences and some similariIn the wake of the Great Recession, some people have
ties. The Great Depression was generally caused by a series
said that we should not have gotten rid of Glass-Steagall or
of banking panics in the United States and the Fed did not
interest rate ceilings or other New Deal regulations, and
do what it should have: act as the lender of last resort to the
they point to how stable the banking system was between
money market. So that’s why a severe recession turned into
the mid-1930s and the early 1970s. What those people forget
a depression. In 2007, the Fed knew about this and it
are the efficiency losses associated with such regulations and
avoided the mistakes that were made from 1930-1933. There
also the fact that the U.S. financial system was losing out
was a liquidity policy in place during the recent crisis. The
relative to financial systems in other countries.
other thing, of course, is that the Great Depression was so
Also, I should say that, while the Fed has not become
much more severe. Real GDP fell by 25 percent from 1929 to
simply an arm of the Treasury following the Great Recession
1933, whereas it fell by 5 percent from 2007 to 2009. And
unemployment went from close to zero up to 25 percent
as it did following the onset of the Great Depression, I think
compared to 5 percent up to 10 percent. So if you go through
its independence has been greatly compromised. During the
Region Focus | Fourth Quarter | 2011
41
heat of the crisis, the Fed itself did a lot of things to cripple
its independence. It got involved in fiscal policy with the
Treasury, it got involved in credit policy by allocating
resources in a very specific manner, it got involved in debt
management through quantitative easing. So the Fed moved
very far away from independence from the fiscal authority.
Monetary policy has become more politicized and the Fed’s
mission has become diluted. I think those changes could
produce very large costs.
RF: What, in your opinion, can the Fed do to get back on
track, so to speak?
Bordo: It needs to get back to basics; it needs to focus on
price stability and stop trying to fine-tune the economy
through highly discretionary policy, and that means following a very transparent policy rule. Preferably, the Fed would
get congressional approval for that rule, so that the Fed can
stop worrying about Congress always being on its back. Also,
if there is a rule, Congress can, in a sense, require the Fed to
prove that it is following it. For instance, under monetary
aggregate targeting, the Fed had to report how it was doing
relative to the targets that had been established. Something
like that is needed to restore independence. I think that
some people mistakenly believe that policy discretion helps
to sustain the independence of the Fed, when it actually
weakens it.
RF: Some historians have argued that the Great
Depression ended due to the industrial buildup prior to
and during World War II. What do you make of that
claim?
Bordo: That explanation is not completely correct. The
recovery from the Great Depression that started in the
spring of 1933 was really rapid — GDP grew something like
36 percent from 1933 to 1936. That was fueled not by monetary policy but largely by Treasury gold policy — in
particular, large gold inflows from the revaluation of gold,
which acted like monetary policy. But the recovery was not
complete in the sense that the real economy did not recover
as quickly as it had declined. So even by 1936, the economy
wasn’t back to where it was when the Great Depression
started. Part of that is consistent with the Cole-Ohanian
story about New Deal policies cartelizing both labor and
product markets, which reduced potential output. So I think
if that hadn’t happened and if we hadn’t had the 1937-1938
severe downturn (which I think had a lot to do with the Fed
doubling reserve requirements and the Treasury sterilizing
gold inflows), the economy would have recovered much
faster. In fact, it grew very quickly between 1938 and the
start of World War II, but we still had unemployment of
more than 10 percent. So the war soaked up a lot of that. But
much of the growth that had been lost during the Great
Depression had already been gained back by the time the
United States entered the war.
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Region Focus | Fourth Quarter | 2011
RF: As you have noted, financial crises tend to result in
fairly significant new regulation. Are there some general
lessons that we can glean from historical examples?
Bordo: One issue is whether there is policy learning. Do you
learn from the mistakes that you made leading up to the crisis? In general, in U.S. history there has been policy learning
but it has worked very slowly. In a lot of other countries,
there has been virtually no policy learning. They have just
gone back to what they were doing before.
The U.S. financial system and regulation have evolved
over 200 years and have gone through some very bad
moments. For instance, by destroying the Second Bank of
the United States in 1836, Andrew Jackson basically removed
any serious form of control over financial instability. So
there was a great deal of turmoil during the rest of the 19th
century. But there was learning that took place because we
developed the national banking system, which was an
improvement over free banking but it still didn’t solve the
problem of the lender of last resort, so we invented the Fed.
And the Fed was designed to be a great improvement — and
it did some good things at the beginning — but in a sense it
didn’t quite learn from previous mistakes and the Great
Depression came along, so it took 25 or 30 years for the Fed
to learn to be a lender of last resort. Given that we tend to
get something out of each crisis, I suspect we will get something positive out of this crisis, but I don’t see it yet.
I have already mentioned many troubling regulations
that came out of the Great Depression but one good thing
that did emerge was deposit insurance. The FDIC removed
the urge for people to panic. But deposit insurance wasn’t
priced properly, which led to moral hazard. Still, it really was
a major innovation, even if it wasn’t recognized at the time.
I think most policymakers viewed Glass-Steagall and the
reform of the Fed as being more important.
RF: Should central banks try to identify and then pop
asset bubbles? If so, are they capable of doing so in a
socially desirable way?
Bordo: I wrote some papers on that topic about 10 years
ago. The first point I would make is that central banks
should be wary of their role in fueling asset price booms
through expansionary policy. I think what we have learned
from the recent crisis is that central bank policy can have a
lot to do with contributing to booms, if not necessarily creating them. So I think that’s something central banks have
to be worried about, and it’s a point that the people at the
Bank for International Settlements have made, even if they
were laughed at for a long time.
In the case of big asset booms that lead to a relatively
high probability of large recessions, I think that a case could
be made for preemptive policy. But I don’t think the Fed
should use its main policy tools to defuse an asset price
boom. I don’t think that the Fed funds rate should be used
for something like that. In fact, I am not even convinced
that the Fed should do it at all.
I think that an agency like, say, the
“Financial Stability Authority” —
and I know that such an agency
doesn’t currently exist in the United
States — should be doing that. In
other countries, that is how it is handled. I am concerned about the Fed
being pushed to downplay its single
most important goal, which is price
stability. I think that financial stability policy is a diversion from that.
If you do have a financial crisis,
the central bank remains the lender
of last resort because it can effectively print money, whereas the Financial
Stability Authority could not. So you
need to have the two agencies act in
close coordination. If it is a true
crisis, the Fed should respond very
quickly, while keeping in mind its
long-run goal. But I don’t think that
the Fed acting in a preemptive manner to defuse asset bubbles is in
general a good idea.
RF: Historically, how have monetary unions within one nationstate — such as the United States
— fared relative to monetary
unions involving multiple nationstates?
Bordo: My work with Lars Jonung as
well as continuing research tells you
loud and clear that monetary unions
within nation-states (that are also
fiscal unions) do a lot better than
international monetary unions. We
looked at the experience of the
Latin Monetary Union and the
Scandinavian Monetary Union in the
19th century. They lasted awhile, but
they lasted only as long as the gold
standard was working and, in a sense,
there was international harmony.
But as soon as World War I hit, they
completely fell apart. So the historical evidence is very clear on that one.
The question now is what will
happen to the eurozone? It’s a hybrid
because they have both unified
goods and factor markets and a single
central bank with one currency. So
they have some of the trappings of a
nation-state but they don’t have a
Michael Bordo
➤ Present Position
Professor of Economics and Director
of the Center for Monetary and
Financial History, Rutgers University
➤ Previous Faculty Appointments
University of South Carolina (1981-1989)
and Carleton University (1969-1981)
➤ Other Positions and
Professional Activities
National Fellow, Hoover Institution,
Stanford University; Member of the
Shadow Open Market Committee; visiting scholar at the Federal Reserve Banks
of Cleveland and Dallas; former visiting
scholar at the International Monetary
Fund, Bank for International
Settlements, Bank of England, Swiss
National Bank, Reserve Bank of New
Zealand, Federal Reserve Board of
Governors, and Federal Reserve Banks
of Richmond and St. Louis; former
consultant to the Bank of Canada and
the World Bank; and former visiting
professor at the University of California
at Los Angeles, Carnegie Mellon
University, Princeton University,
Harvard University, and the University
of Cambridge, among others
➤ Education
B.A. (1963), McGill University; M.Sc.
(1965), London School of Economics;
and Ph.D. (1972), University of Chicago
➤ Selected Publications
Author of The Gold Standard & Related
Regimes: Collected Essays (1999); co-editor
of Credibility and the International
Monetary Regime: A Historical Perspective
(with Ronald MacDonald, 2012),
The Defining Moment: The Great
Depression and the American Economy in
the Twentieth Century (with Claudia
Goldin and Eugene White, 1997),
A Retrospective on the Bretton Woods
System (with Barry Eichengreen, 1993),
and A Retrospective on the Classical Gold
Standard, 1821-1931 (with Anna Schwartz,
1984); and author or co-author of papers
in such journals as the American
Economic Review, Journal of Political
Economy, Journal of Monetary Economics,
Journal of Economic History, and History
of Political Economy
fiscal union. My reading of history is
that unless they go that way, adopt a
fiscal union and move more in the
direction of one large federal nationstate, they are not going to make it.
RF: What do you think ultimately
will happen with the eurozone?
Bordo: In the short run, I think they
are going to keep muddling through,
although I think Greece is likely to
default and there is a good chance it
will exit from the euro area. The Greek
crisis has to be separated from the
other issues. Getting to the rest of it, I
think in the near term the system will
be saved by European Central Bank
(ECB) liquidity, bank recapitalizations,
austerity and some structural reforms.
But ultimately there could end up
being a two-speed euro. In other
words, there are really two economies
there. There is an advanced economy
that is doing quite well and has low
labor unit costs, and this includes
Germany, Finland, the Netherlands,
and possibly Austria, Belgium, and
France. And then you have this other
Europe that is not doing as well, has
high labor unit costs, and is still developing. This would include Portugal,
Greece, Cyprus, Malta, and maybe
Italy and Spain. Unless they can work
out something that would make the
real economies of that second group
more competitive, I think they may
end up splitting into two, with something like a hard euro and a soft euro,
which would permit them to potentially be reunited. So I am not terribly
optimistic about the euro area as it
now stands.
The two-speed euro idea was
discussed before the ECB was
created. You would have all the
advanced countries that would be
pegged to Germany. That would be
the euro area proper. Then the other
countries would have either a peg to,
say, Italy, or they could be floating relative to the euro and be in the same
situation now as Hungary and other
current European Union (EU) members that want to be part of the euro
area. They could be permitted into
Region Focus | Fourth Quarter | 2011
43
the euro area if their economies and fiscal situations started
to converge with the core countries.
What you need to make the euro project work are: a
fiscal union (a euro bond, a euro fiscal authority which can
make transfers, and a euro financial authority), a credible no
bailout policy (even though such a policy was in the
Maastricht Treaty, it has not been followed), and the true
operation of free markets through the mobility of labor,
capital, and goods. On the last point, they need significant
structural change, especially in the labor market. The
Germans have done a lot in that regard fairly recently, but
most of the other countries still look pretty sclerotic.
RF: You have argued that central banking experienced a
“golden age” in the late 19th and early 20th centuries.
What were the most important characteristics of
central banks during this period? How were they able,
on balance, to maintain price stability and effectively
serve as lenders of last resort?
Bordo: The key characteristic of that era is that nearly all
central banks were on the gold standard and were under the
constraints of having to maintain convertibility to gold.
Early central banks, such as the Bank of England, also acted
to provide government finance, but as time went by they
didn’t do much of that. Also, central banks were independent. They were private and they became independent of the
fiscal authorities, because if you are on a gold standard rule,
you cannot permit big deficits. You will get blown out of the
water by capital flight.
What allowed central banks to act as lenders of last
resort was credible adherence to the gold standard rule.
If the markets believed you were going to stick to gold above
all else and keep prices stable, then they would permit you to
print money temporarily to deal with a crisis, because when
the crisis was over they were confident you would withdraw
those funds. Central banks didn’t worry about managing the
macroeconomy and they didn’t worry about coordinating
with fiscal policy. So that’s what I mean when I call that
period the “golden age.”
RF: There is, as you know, a growing movement to
change the United States from a fiat money system to
the gold standard or some other commodity-based
system. What do you think of such proposals? And in
today’s world — given the monetary arrangements of
other countries, for instance — what would be required
to make such a system practicable?
Bordo: Given that the rest of the world wouldn’t go along
with the United States in changing to the gold standard,
pegging the dollar to the price of gold would lead us to be a
sink for global shocks. We would have to absorb all of the
shocks to the gold market from the rest of the world which
would destabilize prices. And that is not to mention the
old problems with the gold standard: that it depends on
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Region Focus | Fourth Quarter | 2011
the growth rate of the world’s monetary gold stock being
equal to growth in the real economy, and if it is less, you will
tend to get deflation, which was an issue in the 19th
century; and Milton Friedman’s argument about the
resource costs of basing money on a commodity that is
costly to produce. These reasons argue that we can do
better with fiat money if that money is issued under a
system of transparent rules.
The good thing about the gold standard is that it gave
long-run price stability because there were restrictions on
how much gold could be produced, and it constrained the
monetary authorities from issuing paper money. They had to
keep the ratio between the issue of paper money and the
monetary gold stock stable. Moreover, on average, prices
were more stable under the gold standard than they have
been since we abandoned it. But if a modern central bank
were to adopt a credible rule and abandon its discretionary
policies, a fiat system can achieve the benefits of the gold
standard without the costs.
RF: What are the big unanswered — or understudied —
questions in monetary economics and policy, in
your view?
Bordo: I think one question that is still important even
though a lot has been written about it is how do you set the
basic monetary rules in a political environment? For
instance, many countries have something like inflation targets, but often they are not followed. How can you set up an
incentive-compatible mechanism and make it work? That’s a
really big question. A second question is how do you follow a
lender of last resort policy without bailouts? I know what
Bagehot’s rule says, but how do you do it? A third question is
how does the central bank stay clear of fiscal entanglements?
It’s one thing to say central banks should not engage in fiscal
policy but yet the Fed did just that. So what can you do to
prevent that from happening? A fourth question is how do
you prevent mission creep? How does a central bank say that
it’s going to handle monetary policy but it will not get
involved in consumer regulation or financial stability
because those things are not their business? A fifth question
is how do you get away from New Keynesian Phillips curve
thinking and back toward a more quantity theory approach?
That might reveal my age, but I think it’s important. And a
sixth question is how do you take into account the rest of the
world when setting monetary policy? The Fed conducts its
policy mainly based on domestic conditions. It generally
takes into account international events only when there are
big crises. But its policies do affect us through the way they
affect the rest of the world. For example, when we keep
interest rates lower than other countries, there are capital
flows abroad that lead to increases in the money supply in
other countries and global inflation, and that comes back
and hits us. This seems like something the Fed should be
paying more attention to and thinking about in a very
RF
systematic way.